Contrarianism

My daughter, like her mama and daddy, is a tad bit independent. 

Being terribly independent myself, I have little problem with that.  But, it can be a bit difficult at times, especially as a parent trying to get a three-year-old to brush her teeth or get dressed in the morning.

One of her teachers, Ms. Karen, was very delicate in communicating this predilection to us.  She used the sandwich approach, saying that Vivian was 1) self-directed, 2) independent to the point of being difficult, and 3) more likely to be a leader than a follower.  Mama and daddy were quite proud despite the obvious and nerve-fraying meat of the sandwich.

Like most parents, we tend to amuse ourselves with our child’s tendencies.  So, to prove Vivian’s independence to others, we simply ask her if she is a contrarian.  Naturally, she proudly states that she is NOT a contrarian (missing the irony of the statement).  Mama and daddy are quite amused, even if at her expense.

The investing world, too, is filled with it’s own Vivians–contrarian to a fault.  They don’t see themselves that way, of course.  In fact, they credit their contrarian approach for their investing success.

Don’t get me wrong, I think a contrarian approach makes a lot of sense, but not as a principle to action.  It makes sense to look at what everyone else is selling; the contrarian trash pile is an excellent place to look for bargains.  But, everything thrown away is not of value, and doing the opposite of everyone is not by itself the best approach to picking investments.

I was reminded of this when I saw how many big, smart, and vastly more-successful-than-me investors had invested in British Petroleum (BP) during the second quarter.

Did they invest in BP simply because everyone was selling?  This makes some sense because it’s obvious that many sellers were irrational, simply selling to get it off their books no matter at what price.  As a trading strategy, I suppose I follow that reasoning.

If you had followed BP for years, understood its value, and then bought when the price tanked, I can understand that, too.  That shows an appreciation for the nature of the investment, the risks involved, and the price to value relationship.

But, to buy it as a long term investment simply because others are selling makes little sense.  As Warren Buffett put it, if you aren’t willing to own an investment for 10 years, why would you want to own it for 10 minutes? 

I didn’t buy BP because I thought it was a terrible company before the Horizon rig blew up in the Gulf of Mexico.  It had been carefully cultivating its green image and spouting “beyond petroleum” blather while racking up lousy returns and the worst environmental record in big oil (just for reference, the most profitable company, Exxon, has one of the best). 

Not only did I judge BP poorly, I also thought its long term risks were almost incalculable.  Few thought Three Mile Island would halt one of the cleanest, most efficient energy sources in America, but it did.  Knowing how irrational people were about that, why would I think a huge oil spill in the Gulf would be different?

Contrarians buy what others are selling without necessarily  understanding their purchase.  The strategy works like a charm…until it doesn’t.  That’s why a lot of contrarians tout their records as proof.  But, investing has a huge element of luck as well as skill, so both short and long records can be deceiving. 

Exhibit 1 is Bill Miller’s record at Legg Mason Value.  He beat the market every year for 15 years, then got crushed from 2006 to 2008 (down -56% vs. the market’s -23%).  I’m certain he did more research than a pure contrarian, but he also owned Bear Stearns, Countrywide Credit, Fannie Mae and a host of other companies with terrible business models.  After all, he had made a fortune and his reputation buying lousy banks in the early 1990’s that were bailed out by the government.  Not surprisingly, he was cursing the government for not bailing out his investments in 2008.

A contrarian approach works as a good starting point, but it’s not the whole enchilada.  You need to do a lot more research and be very honest with yourself (if you don’t really know, you’d better walk away). 

Excellent long term investment results are as much about not stepping on landmines as buying good investments.  A pure contrarian approach will eventually find landmines and lead to a blow-up.

Now, if I could only convince Vivian that contrarianism isn’t its own end…

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

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Contrarianism

What everyone knows.

My favorite Will Rogers quote: “It isn’t what we don’t know that gives us trouble, it’s what we know that ain’t so.”

There’s no better place to illustrate this principle than Wall Street. Stock prices reflect what everyone knows. The problem isn’t what we don’t know, but what we know that just isn’t so.

For example, everyone knows China is a growth engine and that everyone “should” be invested there. If everyone knows it, then stock prices already reflect that fact. If what everyone knows turns out not to be so, then a lot of people are in for a lot of disappointment.

Another example. Everyone knows the cable industry is toast because everyone will download TV and movies over the Internet for free. But, if everyone knows, then stock prices reflect that fact already, so no profits can be made betting against cable. In fact, if everyone knows it, and it turns out not to fully reflect the facts (how will all those people download all those movies and TV shows, perhaps over cable?!), then it might be possible to make money betting the other way.

Everyone knows that bonds and cash are safer than stocks. Perhaps that is why retail investors flooded into bond mutual funds last year and a lot of people pulled their money out of the market and put it into bank accounts. But, what if inflation comes back with a vengeance? What everyone knows will turn out to be very painful for, well, everyone.

What else does everyone know? Old line software companies are toast. Every Apple product is a blockbuster. Google will provide everyone with software for free just because, gee whiz, they’re such nice people. All airlines are lousy investments, always. Content providers will happily provide consumers with high quality entertainment for free over the Internet. Old line pharmaceutical companies are toast. Old line telecom companies are toast. Regulators can see problems coming and act to prevent harm. Global warming is occurring, caused by man, can be stopped, and should be stopped (the benefits outweigh the costs).

The trouble isn’t what we don’t know, or admitting that we don’t know. The trouble comes when what we think we know turns out to be just plain wrong.

A lot of money has been made over the years in buying the opposite of what everyone knows. It’s certainly worked well for me.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Investing in the unloved

The highest returning investments are also the most unloved.

This may sound counter-intuitive at first, but it makes sense when you stand back and think about it.

Great companies, like Google and Apple, that are firing on all cylinders, almost always have share prices that reflects that fact. The very obviousness that such companies are doing well causes investors to flock to those stocks, and hence bid up their shares to very high prices relative to underlying fundamentals. As Warren Buffett puts it, you pay a high price for a cheery consensus. Once everyone loves a stock and has bought it, who is left to buy more?

The companies that are seemingly on the ropes, like Microsoft and Dell (full disclosure: my clients and I both own shares of Microsoft and Dell), on the other hand, have share prices that reflect their tough competitive landscape. Everyone knows that Google is going to crush Microsoft and that Apple is going to crush Dell, so Microsoft and Dell have low share prices relative to their fundamentals. Once everyone who hates a stock has sold it, who is left to sell more?

But, what if what everyone knows to be true isn’t true? What if Microsoft and Dell aren’t completely doomed? What if they do even slightly better than everyone thinks? Then their share prices may perform better than consensus. Actually, once everyone who is going to sell Microsoft and Dell to buy Google and Apple have done so, then there is only one direction share prices can go, and its the opposite of what most people expect.

In my experience, the more hated the company, the more potential for great upside. This isn’t always the case (think: Worldcom, Enron, AIG, Citigroup), but it happens much more frequently than most think.

In fact, I tend to get excited when the consensus comes to such a conclusion. When I tell people I own Comcast (full disclosure: my clients and I own Comcast) and their reaction is, “they are toast, everyone will be watching TV and movies for free over the Internet!”, I just smile and nod. I know that Comcast’s share price reflects this consensus opinion, and that it’s price probably has a lot of upside.

Investing in what is hated is tough. No one will pat you on the back at cocktail parties. But, what would you rather have? Pats on the back, or long run market out-performance? Not everyone agrees with me on this, but it’s an easy choice for me (and I think my clients are happy that I take on that burden for them).

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Headlines frequently call the bottom

One of the amusing things I’ve learned as an investor is how the popular press almost always gets it wrong, especially when it comes to investing or the economy.

One popular magazine called the bottom with their headline about the death of equities in the early 1980’s. Doing the opposite of what this headline seems to suggest–by investing in equities–would have been very profitable.

If you were awake during the late 1990’s, you were inundated with headlines about the telecom, internet and technology companies that were going to grow forever. Once again, doing the opposite–by shorting telecom, technology or internet businesses, or investing in brick and mortar companies–was quite profitable.

More recently, the craze for flipping homes or condos as investments made headlines in the popular press during 2005 and early 2006. Want to guess how thats turning out?

Why does the popular press get it wrong? They don’t tend to ferret out breaking news, they tend to report what is happening. In fact, they only tend to report such news once everyone already knows about it. In other words, they reflect popular sentiment more than anything else.

If everyone believes something is a great deal, they tend to buy it for themselves before they tell everyone how great it is. If everyone knows something is great, then price will already reflect that enthusiasm. If you wait for that enthusiasm to be obvious everywhere, then everyone will have already bought. And, when everyone has already bought, prices almost have to go down from there.

The bust in the housing market and home loans seems to be making the news a lot lately. But, I’m not sure it’s hit page one of a popular weekly magazine, yet, so perhaps it’s not quite time to act on this one.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.